High stress rates driving investors to specialist BTL ‒ analysis

Buy-to-let stress tests are when lenders assess a landlord’s rental income in relation to the mortgage payment and compares the amount a landlord wants to borrow versus the rental income and interest they pay on the loan.

Interest rate assumptions have been increased following the successive increases to the base rate by the Bank of England to curb inflation.

Brokers said that lenders usually require a buffer in rental income of 125 per cent to 145 per cent, depending on tax status. Lenders then do a stress test to factor in the ability to pay an interest rate of between seven and eight per cent dependent on the term.

Chris Sykes, technical director at Private Finance, said that specialist lenders normally have a stress rate of 125 per cent for limited companies or basic rate taxpayers and 140 to 145 per cent for higher rate personal names with stress rates around five per cent.

However, he said that specialist lender rate would have high fees as “banks trade off stress rates and overall costs of product and funds”.

Sykes continued: “These stress rates are a huge difference from a few years ago. If someone maximised borrowing two years ago this may have been a 125 per cent at 3.5 per cent stress rate, so going in now they may only have the option if needing to remortgage of going onto standard variable rate (SVR), selling or sticking with their current lender as I’ve seen in some scenarios.”

He added that landlords can now borrow hundreds of thousands of pounds less than they have outstanding, even if rents have increase and property values have gone up.

“This has meant a lot of landlords are seeing what they can do, for example restructuring personal debt into a limited company structure to get better stress rates and be more tax efficient long term,” Sykes noted.

He said that some landlords were moving away from single lets and were favouring commercial property, holiday lets, houses in multiple occupation (HMO), multi-unit freehold blocks (MUFB) and semi-commercial properties.

Other landlords were selling properties to pay down others or withdrawing other investments to own their buy-to-let properties in cash, and some landlords are moving into development or adding value to property they buy via heavy refurbishment to flip or finance long term.

Sykes said that the company was “exploring a lot of different options for landlords, helping to educate them on their options so they can make informed decisions about their portfolio moving forward”.

Stress rates has led landlords to ‘being stuck like a spider in a bathtub’

Stephen Perkins, managing director at Yellow Brick Mortgages, said that landlords were “being stuck like a spider in a bathtub” with the increased stress-testing rates on buy-to-let mortgages.

“It completely stops new purchases without large deposits and even remortgaging to a different lender is often not an option. So, the landlord can product transfer or sell the property,” he added.

He continued that most investors saw houses in multiple occupation (HMO) and holiday lets as the “only good margin property options”.

Elliott Culley, director at Switch Mortgage Finance, said that landlords were seeking two-year products, mostly due to the economic forecast currently predicting an improved base rate in 2025.

However, stress rates on two-year products were still “difficult to achieve”, especially for highly-geared properties on a single family assured shorthold tenancy (AST) basis, so it was seeing a few product transfers as a result.

“Specialist lenders are trying to combat this by offering lower rates but with higher arrangement fees. However, I don’t think that’s the long-term answer and the current universal affordability model should be looked at,” he added.

Lenders need to simplify stress rate process

Perkins added that stress testing for buy to let was “nonsensical”, explaining that most loans were interest-only and at lower loan to value (LTV) tiers, making the increases in payments usually less than residential mortgage holders, the rates are already higher and typically as rates increase, as do the rental payments landlords can charge.

“Personally, lenders should base it on the current product rate at 125 per cent and simplify the process and affordability,” he noted.

Peter Stamford, director and lead adviser at Moor Mortgages, said that landlords were “feeling trapped” with the higher stress rates as it made buying or switching “tough without hefty deposits”.

“While interest rates might rise, rents often follow suit. Lenders should simplify the process, focusing on current rates and affordability.

“Looking to the future and hoping for reduced rates isn’t good enough, we need action now,” he added.

James Bull, mortgage broker at JB Mortgages, said: “There are a few lenders who allow any shortfall in stress rates to be covered by personal income, ie top slicing. These mortgages have been recommended more and more regularly recently so landlords can borrow the amount required, this is expected to continue to be the case as long as interest rates stay at their current levels.”

Sykes noted that buy-to-let properties have “actually just become a much better investment over time if owning in cash as rental yields have generally increased, and you are unaffected by mortgage”.